Using its modified duration, the price of a coupon bond is forecasted to change from $990 to $925 due to an increase in interest rates. If the bond's convexity is considered, the new forecasted price of the bond will be:
A) higher than $925.
B) lower than $925.
C) equal to $925.
D) Cannot be determined.

Question

Quizplus · Accepted Answer

Convexity accounts for the curvature in the price-yield relationship of bonds, providing a more accurate price change estimate. When interest rates rise, convexity will adjust the price change to be less severe than predicted by duration alone, resulting in a higher price than $925.

Using Its Modified Duration, the Price of a Coupon Bond